investing
Economic indicators

An early warning system for recessions would be a great immune-booster for your financial health.

Stock market downturns during recessions are often deeper (almost 50 percent in 2001) and last longer (the average is about 16 months) than bear markets that occur for other reasons.

“Has the economy been fun for too long?”

Compounding the problem, recessions lead to lower interest rates on savings because the Federal Reserve Board cuts the federal funds rate to boost the economy. Worse yet, layoffs are common during recessions, so you don't want to make financial decisions that aren't affordable on unemployment.

The problem is, recessions are difficult to recognize when they arrive and almost impossible to predict. In fact, it takes a while, sometimes a long while, to find out that a recession has already begun. The official announcement of the recession that began in March 2001 didn't come out until November 2001, eight months later. The announcement of the end of that recession came almost two years after the fact.

What is a recession anyway? In short, it's a slowing in economic growth. A rule of thumb definition is a decline in the Gross Domestic Product, or GDP, for two or more consecutive quarters -- in other words, a decrease for two consecutive quarters in the total market value of what consumers, investors and the government spend (plus the value of exports, minus the value of imports).

Definitions 
  • Federal funds rate -- The short-term interest rate that banks charge other banks to borrow money overnight at the Federal Reserve.
See the Guide's Glossary for a further explanation of these terms.
But, the economic good times aren't officially over until the National Bureau of Economic Research, or NBER, sings. The NBER's Business Cycle Dating Committee, comprised of business cycle experts, is responsible for calling the start and end of recessions and it places little weight on the GDP. Instead, the committee members evaluate a variety of other economic indicators and statistics to determine whether an economic decline earns the title of recession.

So, a group of experts noodle over numbers for months and finally announce a recession long after it starts. What you need is a way to recognize a recession before your investments and savings interest rates tank. What's the average Joe supposed to do?

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Common sense and keen observation can help you spot the signs of recession, says Don Cassidy, president of the Retirement Investing Institute. Because a recession is a decline in the overall economy, he recommends watching business activity where you live and reading what newspapers and magazines report.

His first and completely unscientific method for deciding whether a recession is on the horizon is, "Has the economy been fun for too long?"

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